Europe’s Hamiltonian Moment

The proposed sum for the recovery fund proposed by French President Emmanuel Macron and German Chancellor Angela Merkel is small change in an era when politicians and central bankers conjure up trillions almost daily. But, if adopted, the proposal might be remembered as the moment when Europe became a genuine political federation.

LONDON – The new Franco-German proposal for a €500 billion ($547 billion) European recovery fund could turn out to be the most important historic consequence of the coronavirus. It is even conceivable that the deal struck between German Chancellor Angela Merkel and French President Emmanuel Macron might one day be remembered as the European Union’s “Hamiltonian moment,” comparable to the 1790 agreement between Alexander Hamilton and Thomas Jefferson on public borrowing, which helped to turn the United States, a confederation with little central government, into a genuine political federation.

Admittedly, this sounds hyperbolic. The proposed sum for the recovery fund is small change in an era when politicians and central bankers conjure up trillions almost daily. And what about the gulf between words and action throughout the EU’s history? Skepticism about the Franco-German proposal is certainly understandable and may prove justified.

The plan amounts to only 3% of the EU’s GDP, compared with the 15% of GDP already committed by Germany to industrial support. Creating any EU recovery plan will require unanimous support from the EU’s 27 member countries – and this will involve unseemly late-night squabbles between the self-styled “Frugal Four” northern governments (the Netherlands, Austria, Finland, and Sweden), which have vehemently opposed funding for Mediterranean EU members which, according to Wopke Hoekstra, the Dutch Finance Minister, have mainly themselves to blame for “failing to reform.”

But to focus on these drawbacks is to miss the potential significance of the plan. What makes the Merkel-Macron deal a potential game changer is not the sum of money or their apparent backing for grants over loans; it is the financial mechanism to which both Merkel and Macron are now publicly committed and must now deliver or suffer enormous loss of face.

The Merkel-Macron proposal involves three crucial innovations, which may sound tediously technical but will vastly increase the flexibility of EU fiscal policy and could ultimately transform European politics in a way that really proves comparable to the Hamilton-Jefferson deal.

The key innovation is financing the recovery fund with bonds issued directly by the EU in its own name and guaranteed by its own revenues, instead of using funds raised by national governments, whether acting together or separately. Merkel presumably insisted on this mechanism to avoid the vexations of jointly guaranteed “Eurobonds,” which German public opinion deems politically toxic and possibly unconstitutional, because German taxes could end up paying for Italian or Spanish debts.

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But by relying on the EU, instead of national governments, to issue bonds, the Merkel-Macron plan implies a second, more controversial, innovation, which is clearly necessary to create a fiscal federation, but which European politicians have always tried to avoid.

To guarantee and service hundreds of billions of euros of new borrowing on its own account, the EU will require more tax revenue than it now receives. Merkel and Macron have therefore proposed increasing the European Commission’s budget from 1.2% to 2% of EU gross national income, yielding about €180 billion per year in extra revenue.

To raise this amount, the EU will need to levy new taxes on its own account, in addition to the customs duties and small share of national VAT revenues which already flow automatically to Brussels. The exact nature of the EU’s new taxes will presumably be the subject of fierce debate and fiercer lobbying.

But a broad consensus seems to be emerging that pan-European taxes should be based on economic activities that transcend national boundaries, such as carbon dioxide emissions, financial transactions, and digital transactions. Some of this extra tax revenue will flow into recovery projects, but most will be needed for other EU spending, such as the “cohesion funds,” which subsidize the poorer eastern countries (and help to buy off governments that might otherwise block the recovery fund and other EU initiatives and reforms) – and also to replace the United Kingdom’s net contributions of roughly €10 billion per year.

That leads to the third game-changing innovation in the Merkel-Macron plan: permitting the EU to leverage its activities with borrowing, instead of just using the EU budget as a pass-through mechanism from pan-European taxes to current spending. Because of today’s near-zero interest rates for triple-A sovereign borrowers, the leverage potentially available to the EU from a modest amount of extra revenue is enormous.

If the EU issued ten-year bonds, it would probably pay interest of zero or below, potentially allowing almost unlimited borrowing, albeit with sinking funds to redeem the debts at maturity. But even a 50-year bond could probably be issued with a coupon no higher than the 0.5% yield on Austria’s 50-year bond.

Better still, the EU could issue perpetual bonds with no redemption date, similar to the now-retired British and US “consols,” as proposed by the Spanish government and George Soros. This would allow the EU to borrow €500 billion at an interest cost of just €2.5 billion per year.

To put it another way, if the EU borrows €500 billion this year for a European recovery fund, then it could easily borrow another €1 trillion next year for a digital inclusion fund, and then maybe €2 trillion for a vehicle electrification fund or €3 trillion for a comprehensive climate-change fund. Such simple calculations show why European economic and political conditions could be completely transformed by the Merkel-Macron plan’s financial innovations.

There are big obstacles in achieving the unanimity the plan requires. The Frugal Four will vehemently object to offering grants, rather than loans, to the bloc’s Mediterranean members. But it is hard to imagine that any of these governments will try to sabotage completely an initiative that equally “frugal” Germans support. Instead, the debate in Europe will probably accept the three technical principles just outlined, but focus instead on two separate controversies: the amount of new EU borrowing and whether EU support should take the form of loans or outright grants.

On these two issues, a compromise acceptable to both sides should not be difficult to forge. The size of the recovery fund could be increased to something near the €1 trillion recommended by the European Commission without imposing any strain on the EU budget. But in exchange, the Frugals could insist on offering 50% of the support through loans instead of grants.

A compromise like this would make the Merkel-Macron plan even stronger. Loans with near-zero interest rates and long maturities are economically almost equivalent to grants. And using loans instead of grants would make EU debt financially more sustainable, thereby maximizing the scope for further borrowing without risking the bloc’s triple-A rating.

The scope for such compromises suggests the EU could readily agree on a powerful recovery plan that preserves all three essential elements of the Merkel-Macron proposal: bonds issued by the EU in its own name; pan-European taxes on cross-border activities; and leverage to benefit from low interest rates. If EU leaders can rise to this challenge, Europe’s “Hamiltonian moment” will finally have arrived.

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Anatole Kaletsky is Chief Economist and Co-Chairman of Gavekal Dragonomics. A former columnist at the Times of London, the International New York Times and the Financial Times, he is the author of Capitalism 4.0: The Birth of a New Economy in the Aftermath of Crisis, which anticipated many of the post-crisis transformations of the global economy. His 1985 book, Costs of Default, became an influential primer for Latin American and Asian governments negotiating debt defaults and restructurings with banks and the IMF.

We do not need a Hamilton moment in the EU. That moment is seen as the act that turned in 1790 the USA from a confederation with a little central government, into a genuine political federation ( a bloc).Given the diversity of the EU members, which makes it uncomaparable to the USA, it has to determine its own future.The EU began as the successful common market called the EEC. By the decision to form a political EU and in particular by the implementation of the Euro the EU has moved on to the wrong track.The EU has lost its competitiveness, decisions are not made, frictions between members increase, cohesion is lost.A crises is also often the right moment to bring about changes.My suggestion is to prepare a plan for a new EU.A plan that will make the EU more competitive, that will make it a lean and dynamic organisation able to meet the challenges in to-days rapidly changing world.It is of vital importance for the less competitive members as well as the entire EU that competitivity significantly increases.Between 2009-2017 the EU economy shrank by 2,4 %. Over the same period the US economy increased by 39 %, the Chinese by 139 %.The EU could significantly improve in the clearity of its organisation and in the relationships with the EU members.Therefore I suggest that the EU members in the top 10 of the Global Competitiveness Index of 2018 form a group to draw up such plan.These members are: Germany, the Netherlands, Sweden, Denmark.This Juli Germany wil be leading the EU. It would add to the legacy of mrs. Merkel if she could launch such a group.

A small point on the U.S.'s political structure. While Mr. Crop is fair in saying that there was "little central government" under the Articles of Confederation (he might just as well have said "no central government"), what the U.S. Constitution did was to abolish a "federation" of independent states and create a USG that is sovereign over all U.S. territory, including lots of territory that was not part of any state.

Most of the present U.S. states were created by the USG out of U.S. territory by legally permitting people who were already U.S. citizens to migrate to those territories for the purpose of getting Congress's permission to organize new states. (In a couple cases, U.S. citizens jumped the legal migration gun, but with the same intent.)

Indiana, from where I write, hardly federated itself with other states.

U.S. governance needs to be seen in the context of the vision of a continental empire, starting with the trans-Appalachian land won by war from (sequentially) France, Great Britain, and the indigenous. That's a major sense in which it differs from present-day Europe's case.

Although the USD is the common instrument of "money" for all states in the union interest rates are not universal. They vary a lot between the states depending on performance. The financial market sets the interest!

There is no word about taxes in this Merkel-Macron plan. It's only about borrowing against future contributions of the Member States. Therefore, there is no Hamilton moment. It's rather Wall Street moment. A consolidation of the supremacy of the financial markets rule over republican rule.

Anatole Kaletsky says the €500 bn ($547 bn) “European Recovery Fund” jointly proposed by Emmanuel Macron and Angela Merkel, could turn out to be “the most important historic consequence” of Covid-19, and might one day be remembered as Europe’s “Hamiltonian moment” – comparable to the agreement on public borrowing between Thomas Jefferson and his political nemesis Alexander Hamilton. The Compromise of 1790 helped – just as the assumption of state debt by the government – transform the US, a confederation with little central government, into a genuine political federation. Whether an emerging deal in Europe could complete the continent’s unfinished integration – a fiscal union – remains to be seen. A progress toward that end is expected to be slow, fitful, incremental. Yet a monetary union with only relatively loosely coordinated economic and fiscal policies is not powerful enough to prevent the kind crises the Eurozone has seen. Its member states need to be more agile, and pool their economic strength, making financial backstops more flexible to contain market turbulences etc. The recovery fund – a common debt instrument to be administered through the EU’s budget, financed by EU-issued debt and funneled to the regions worst hit by Covid-19, including Italy and Spain – should be a grant, not a loan, which would avoid increasing the debts of the economies already weak before the pandemic. Both Macron and Merkel had made concession: Initially Macron wanted a trillion or more. But such grants would probably be too much for Merkel to swallow on behalf of her fellow taxpayers.Nevertheless the proposed sum – €500 bn – is a paltry compared to the €1.1 trillion rescue package approved by the Upper House of Germany's Parliament to shield Europe's largest economy from the impact of the pandemic. Members of the European Parliament have recently approved a resolution calling for a €2 trillion recovery fund to rebuild Europe’s economy, after repeated calls from Italy for the issue of "coronabonds" - common eurozone bonds - to demonstrate the bloc’s solidarity.Teem with enthusiasm the author says the Merkel-Macron deal is “a potential game changer,” because it involves “three crucial innovations, which may sound tediously technical but will vastly increase the flexibility of EU fiscal policy and could ultimately transform European politics in a way that really proves comparable to the Hamilton-Jefferson deal.” Now the two are publicly “committed” to this “financial mechanism,” and they must “deliver or suffer enormous loss of face.”Whether Macron and Merkel can convince all the other 25 national leaders to go along with their idea is uncertain. The 17 nations of the eurozone understand that they must more fully collectivise responsibility for public debt and cede some control over their finances to a central authority. The current debt crisis – the threat of a default by a major nation, the possible splintering of the monetary union – hangs like the Sword of Damocles over their heads. Nevertheless for Germany in particular, even this first step already amounts to a dramatic change. A country that has consistently rejected any notion of a European “transfer union” or “mutualised borrowing” is now pushing for a soft and temporary form of both. Merkel and the German establishment have been genuinely shaken by polls showing Italians turning into Euroskeptics, and by the spectre of the EU becoming irrelevant or even failing outright. Berlin’s foreign policy is premised on both transatlantic and European integration. With the US-German relationship already turning sour, the prospect of a dissolving EU constitutes an existential fear across the country.Despite a surge in popularity, Merkel personally and her compatriots generally remain as reluctant as ever to assume the mantle of European hegemony. But she has clearly decided that Germany must at least be seen to assume its traditional position again as co-rider of the Franco-German “tandem” that had pulled Europe forward since the 1950s. The author’s detailed plan on how the recovery fund be financed looks good on paper. It is still unclear how to put it into practice. Even if the usual suspects, the self-styled “Frugal Four” in the north – Austria, Finland, Sweden and the Netherlands – would come on board of the Franco-German Tandem, there is no guarantee that their leaders will have the support of their voters. Like the Germans, they are fiscally conservative and philosophically opposed to mutual debt and transfers within Europe. They are especially aghast at the idea that the new fund should give out grants rather than loans.

An interesting overall picture of what has been going on and what needs to change (namely in respect to a common fiscal policy).But unless political leaders put the EU interest above their short-term political national interests / careers, the EU breakdown initiated in in 2009 will continue its tendence. Maybe now we can all find a turning point, or simply let de disagregation continue.

Without any support from the electorate in the nation states or political mandate, its not exactly hard to see this leading to anything other than another big backlash. It is certainly not a Hamiltonian moment. Macron is perfect example. The guy is deeply unpopular in France with disastrous approval ratings. Its actually hard to believe how unpopular he is inside France, yet instead of moving to address French issues he continues to push and push for 'more Europe'. In opinion polling, the French electorate have become more and more eurosceptic every year. It has become clear that the EU elite politicians like Macron and Merkel have lost touch with the views of their electorates. They are continuing to push integrationist policies too much and the people will not accept it. They did not vote for it. Alexander Hamilton was a great statesman, politician, legal scholar, military commander, lawyer, banker, and economist - Emmanuel Macron is nothing but an arrogant, out of touch and failing French President, who his own electorate have completely lost confidence in (and a majority despise). To compare him to Alexander Hamilton of 'Europe' is ludicrous.

Would Alexander Hamilton and Thomas Jefferson on public borrowing have, for the risk weighted bank capital requirements, agreed on assigning all of its states a 0% risk weight, even though none could print dollars? That’s what EU did to the Eurozone’s debtshttps://teawithft.blogspot.com/2019/06/the-still-ticking-0-risk-weight.html

I do not think the 500 million Euro grant will make a historic event.It does not address the issues that keep the EU divided.It is meant to help fighting a natural disaster rather than flaws in economic management.

Besides, the corrona pandemic demonstrated well the status of European Integration.Each Government took its own steps to fight the virus.What is more. The people turned to their own Govenment for protection, not to the EU.It showed the EU project once more as a chess game by and for the elite.

Considering the constitutional and institutional set-up of the EU, the Macron/Merkel Plan will bring the EU deeper into the " post-democratic, federalist, executive dictatorship" as Jürgen Habermas called the EU. There is nothing Hamiltonian about it. We already have an ECB balance sheet, we have an excessive amount of club-med-debt papers with French financial institutions, and we have target-2-balances at national central banks, some with accounts receivable and others with accounts payable. We may be entering a new phase of animosity and hatred between European peoples as soon as broader parts of the population start to realise who finances what and where. I sincerely hope that said plan will not stand.

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